Outback Outfitters is a manufacturer of recreational equipment.It has been experiencing an average growth rate of 20% in salesover the past 5 years. It is August 31 and the financial controllerhas just prepared the company’s budgeted income statement for nextyear. The company has no sales force of its own and outsourcing itsselling and marketing functions to an independent sales agents. Thecommission paid to the agent is 12% on sales for all the differentproducts the company sold. The statement follows:
Outback Outfitters |
BudgetedIncome Statement |
For the YearEnded December 31 (in thousand dollars) |
Sales | | $100,000 |
Manufacturing expenses: | | |
Variable | $40,000 | |
Fixed overhead | 20,000 | 60,000 |
Gross margin | | 40,000 |
Selling and administrativeexpenses: | | |
Commissions toagents | 12,000 | |
Fixed marketingexpenses | 1,000 | |
Fixed administrativeexpenses | 12,000 | 25,000 |
Net operating income | | $15,000 |
When the financial controller handed the statement to the CEO,the CEO informed the controller that the sales agent demanded anincrease in the commission rate to 16% next year to cover theincreasing expenses in marketing and selling the products ofOutback Outfitters.
The CEO concerns that the sales agent might ask for furtherincrease in the commission rate in the future and would like to setup its own sales team. He asks the help of the financial controllerand he gathers the following information for setting up the salesteam:
Commission rate to own sales team8%
Annual salaries paid to sales manager | $ 600,000 |
Annual salaries paid to salespersons | 3,600,000 |
Travel and entertainment | 2,400,000 |
Advertising | 4,000,000 |
Total additional fixed expenses | $10,600,000 |
Required:
a. Prepare a contribution marginincome statement for next year at the 16% commission rate.
b. Calculate the contribution marginratio and break-even in dollar sales for next year assuming:
(1) Commission rate remains at12%.
(2) Commission rate is increased to16%.
c. Determine the volume of sales under16% commission rate that would be required to generate the same netoperating income under the 12% commission rate. Compute the marginof safety percentage under 16% commission rate.
d. Calculate the contribution marginratio, break-even dollar sales and margin of safety if the companyemploys its own sales team.
e. Determine the volume of sales atwhich the net operating income would be equal regardless of whetherthe company sells through agents at 16% commission rate or employsits own sales team.
f. What is meant by the term operatingleverage? Calculate the degree of operating leverage that thecompany would expect to have for next year assuming the company (1)sells through agents at 16% commission rate and (2) employs its ownsales team.
g. Based on the data in (a) through (f) above, make arecommendation as to whether the company should continue to usesales agent (at 16% commission rate) or employ its own sales team.Give reasons for your answer.
